Optimal Monetary and Transfer Policy in a Liquidity Trap

Abstract

Optimal monetary and fiscal policy are jointly analyzed in a heterogeneous two‐agent New Keynesian environment, where fiscal policy is modeled as lump‐sum transfers. Transfer policy does not substitute for forward guidance—as it entails consumption dispersion costs—nor affect its optimal duration. The stay at the zero lower bound is indeed influenced through two offsetting channels: a shortening channel works through an initial increase in transfers that mitigates the recession (reducing the need for forward guidance), while a lengthening channel works through a later transfer cut that curbs the expansion (making forward guidance desirable for a longer horizon).